What is Debt to Income? via @homebidz

What is Debt to Income Ratio?

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When you’re looking for a home, your financial vocabulary will quickly grow. Debt to income ratio, or DTI, as it is commonly called, can be a bit tricky to fully wrap your head around. Here's a simple explanation, so you can gain a better understanding.

Types of DTIs

First, let’s clarify a few things. There are two kinds of DTIs, Front-End and Back-End. These ratios help the bank decide whether or not they think you’ll have the income to cover the cost of the loan. This actually protects both you and the bank, ensuring that neither party is biting off more than they can chew.

Explanation of Front-End DTI

Let’s discuss the front-end ratio first. This formula takes the gross income of the parties interested in borrowing and calculates how much of their income would be needed to cover their housing costs. Don’t make a mistake and think that this is just a mortgage. This is your monthly mortgage payment, your Private Mortgage Insurance (PMI), closing costs, or other fees associated with purchasing your home. Depending on the ratio, your bank will either refuse the loan, or offer it at a certain interest rate. Typically, no more than ⅓ of your monthly income should be going towards housing costs.

Understanding the Back-End DTI

Next, the back-end DTI: This ratio takes into account how much of your gross income is dedicated to paying back debt. This includes credit card debt, cell phone bills, your car payment, mortgages, etc. These two ratios help the bank paint a financial picture of those who are applying for mortgages. Keeping your debt and monthly expenses low will lower the back-end DTI, while increasing your down payment or finding a less-expensive home can help your front-end DTI.

Final Thoughts

After having a look at both front and back-end DTIs, you should have a better idea how your financial institution will calculate these ratios. Make sure that you're in good financial shape before you go in to apply for a loan, since you'll surely see an inquiry pop up on your credit report each time you apply. So, make sure you're set before you get in too deep.

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